Monolith Reflects: how Ethereum will become the backbone of Web3
When Satoshi Nakamoto released the Bitcoin whitepaper in 2008, they referred to their revolutionary creation as “a peer-to-peer electronic cash system”. Nakamoto envisioned a world where value could be exchanged free from intermediaries, and cryptography would be used to verify every transaction. Unlike traditional currencies, it would run entirely on the Internet.
Bitcoin quickly caught on in the Cypherpunk community, an Internet-native group best known for its privacy-focussed ideals. In their online communications, Nakamoto also referred to the Libertarian movement; they hinted that Bitcoin was created in the pursuit of freedom. The first cryptocurrency also appeared to be a stand against a broken financial system. Nakamoto launched Bitcoin in January 2009; they were working on it during the fallout from the Global Financial Crisis. The Genesis block famously featured a timestamp that read “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”, a reference to the front page of The Times newspaper on the same day.
Now over a decade into its lifetime, Bitcoin’s value proposition has gone through a few notable changes. Though the network is still used as a payment mechanism, processing around 300,000 transactions daily, Bitcoin has become more widely known as a store-of-value as its price has increased. It’s often described as “digital gold” owing to its provable scarcity. There will never be more than 21 million Bitcoin, something that can’t be said of traditional currencies.
Bitcoin is borderless and permissionless, which can make it a useful medium of exchange. More than just a form of “digital gold”, it’s been adopted as a currency in developing countries facing economic troubles, including Zimbabwe, Iran, and Venezuela. On the other end of the spectrum, it’s recently seen wider adoption among institutional investors, leading some to suggest that it’s reached a point of mainstream acceptance. Investment banks now suggest an allocation. Elon Musk is a known proponent. And companies like PayPal have made clear moves towards adopting the asset.
Bitcoin was the first cryptocurrency, and though its main narrative has shifted from Nakamoto’s early vision, it’s been a wild success. A disruptive invention built on the principle of trustlessness, it’s as much a powerful social movement as it is a tool that disrupts the traditional finance system. As a result of its success over the last decade, Bitcoin may always be the world’s most popular cryptocurrency.
But for all its enduring appeal, Bitcoin has some limitations. Transactions can be slow and costly as they need to be validated by every full node on the network. It uses a power-intensive Proof-of-Work consensus mechanism. At some point the supply may need to be increased to maintain the security of the network. And while revolutionary, it offers less scope than some other digital assets.
Since Bitcoin’s launch, smart contracts have added a new level of functionality to many newer blockchains. Pioneered by cypherpunk and early Bitcoin supporter Nick Szabo, smart contracts enable programmability for digital scarcity, which adds a level of functionality that doesn’t exist with Nakamoto’s cryptocurrency. The first blockchain-based smart contract platform was Ethereum, launched by Vitalik Buterin in 2015 and now a vast ecosystem processing over 1 million transactions daily.
Though Ethereum is younger than Bitcoin, the Lindy effect still applies; now that it’s six years old, Ethereum has an better chance of succeeding on a long-term basis. Like Bitcoin, Ethereum is a time-tested innovation whose popularity has grown over the years. It works differently to Bitcoin, though. Ethereum has laid the foundations for what’s been called “Web3” — a nascent, decentralised iteration of the Internet, where users can enjoy self-sovereignty without trusting the centralised authorities that dominate Web2. Many believe that this world will create a societal shift that could be as transformative as the Internet itself.
Ethereum runs its own programming language called Solidity. Smart contracts can be written in Solidity and deployed on the network. Executing transactions requires paying a gas fee, a small denomination of ETH, the blockchain’s native currency. ETH is often described as a “programmable” asset — it has the same global, permissionless qualities as BTC, only it offers more functionality. As the base currency for Ethereum, ETH acts as the reserve asset for many of the activities you can carry out on the network.
Arguably the main use case for Ethereum today is the emergent decentralised finance sector. Commonly referred to as “DeFi”, this space has brought over $60 billion in total value locked onto Ethereum. In early 2020, DeFi was at only $600 million. In DeFi, you can lend, borrow, earn, stake, spend, invest, trade, and much more through smart contracts. The power of composability in DeFi allows makes it possible to virtually stack value in building blocks, which has led some to refer to DeFi’s apps as “money legos”. Ethereum has quickly established itself as the home of DeFi; Synthetix, Aave, Uniswap and other leading protocols that make up the ecosystem run on top of it. According to data from Dune Analytics, there are now over 1.5 million unique addresses using DeFi protocols on Ethereum.
DeFi has also paved the way for the creation of stablecoins, synthetic assets that track the price of traditional currencies like the US dollar. They provide a way to leverage the power of blockchain without experiencing the price volatility other crypto assets are known for. Stablecoins have been adopted by Visa and Mastercard, and they’ve even been used to fight hyperinflation in Venezuela. Most stablecoins are Ethereum-compatible ERC-20 tokens; they account for over $30 billion of value on the network today.
While DeFi has seen exponential growth over the last year, there are many other exciting developments happening in Web3. Another of the most promising evolutions of the last few years is the emergence of NFTs — non-fungible tokens that offer provable ownership and scarcity of an asset. They work differently to cryptocurrencies like BTC, as they are not interchangeable — each one is unique to its owner. NFTs first blew up in the digital art world. One of the scene’s central figures is Beeple, whose crypto artwork was auctioned at the world-famous auction house Christie’s in March. The sale memorably raised $69.34 million, making Beeple the third most valuable living artist sold at an auction.
Alongside many other major artists, Beeple helped NFTs hit the mainstream, but the technology has many uses beyond digital art. NFTs can also encompass music, gaming assets, tickets, certificates of authenticity, identification and likely other uses we haven’t yet imagined. In years to come, their disruptive potential could be limitless. Like DeFi, Ethereum has become the main hub for the fast-growing NFT space. Because the space has developed on Ethereum, ETH is the reserve asset for NFTs.
Ethereum is not the only blockchain that supports innovations like DeFi and NFTs. Other smart contract platforms are hoping to grab from Ethereum’s market share in the coming years, some of them promising improvements like faster transactions. However, they often compromise on decentralisation: transactions can be processed faster with fewer network nodes, but that makes the chain more centralised. While some platforms could succeed in attracting new users, none of them benefit from the same network effects that Ethereum has. Many projects have recognised this and embraced a move towards interoperability, acting as “sidechains” with Ethereum as the main hub of activity. Unlike many other chains, Ethereum is taking a long route to achieve security, scalability and decentralisation. Buterin has famously used the phrase “scalability trilemma” in reference to these elements of a blockchain.
The main development the blockchain is working is Ethereum 2.0, an upgrade that will see the network move towards sharding as a way of achieving scaling. Ethereum 2.0, also known as Serenity, involves a move towards a Proof-of-Stake consensus algorithm (similarly to Bitcoin, the network’s current mechanism is Proof-of-Work). When Ethereum moves to Proof-of-Stake for consensus, ETH holders will be able to validate transactions by staking their holdings. Staking deposits opened ahead of the launch of Ethereum’s Beacon Chain in late 2020, and over 4 million ETH has been deposited to date. Those who stake their ETH can earn yield, around 7.8% today, in exchange for securing the network.
While the completion date for Serenity is likely a few years away, Ethereum is preparing for other major developments on the horizon. An update called EIP-1559 will see a portion of Ethereum’s gas fees get burned as an ETH buyback mechanism. When shipped, it will reduce the ETH supply, potentially making it a deflationary asset.
Furthermore, to help scale the network before sharding goes live, Ethereum’s scalability will improve through the implementation of Layer 2 solutions. With Ethereum acting as the secure settlement layer, these solutions aim to process transactions at a high speed and low cost by building on top of the base chain. Layer 2 solutions come in various forms, though the most anticipated might be rollups. There are two varieties of rollups: ZK-rollups and optimistic rollups, and they both work by grouping transactions together to reduce the load on Ethereum. It’s hoped that Layer 2 will make using Ethereum a smoother and more affordable experience. We’ve spent a lot of time researching Layer 2, and although the available solutions aren’t suitable for all projects, they should help the network scale alongside Serenity.
Many have started to notice Ethereum’s future potential. Alongside Bitcoin, Ethereum is the second blockchain project that’s begun to attract institutional interest (it’s also the second-ranked blockchain by market cap, behind only Bitcoin). While Bitcoin is still the best known crypto asset, Ethereum’s role as a base layer for smart contract applications has helped push the project into mainstream consciousness. ETH futures went live on the world’s largest derivatives exchange, CME Group, in March 2021, while funds like Grayscale have been accumulating the asset with future growth in mind. As awareness of the cryptocurrency space extends to more people, Ethereum is closely following behind Bitcoin in drawing interest.
In conclusion, there is little doubt that cryptocurrencies are here to stay. With Bitcoin as the catalyst that introduced Internet finance to the world, Ethereum has emerged and spawned a whole ecosystem of its own. For both networks, decentralisation is the fundamental guiding principle. While other chains will form part of the world they’ve created, the developments happening in the Ethereum ecosystem should help cement its place as the underlying base layer of Web3. DeFi, NFTs, Layer 2, EIP-1559, Proof-of-Stake, sharding, scaling, mainstream adoption — the journey has barely started, but Ethereum has already hit escape velocity. Like Nakamoto planned for, the Internet finance revolution is here. Once Web3 is fully realised, Ethereum is sure to play the starring role.
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